The old guard is getting streetwise

By James Hall

12:01AM GMT 19 Nov 2006

Although the rise of iTunes is harming the bottom line of the traditional players in the music industry, there are signs that the likes of EMI and HMV are getting attuned to the new age. James Hall reports

The Boomtown Rats might have sung about not liking Mondays, but it is a day the record industry cannot afford to ignore. Tomorrow is Super Monday; the biggest day in the year for new album releases, a day that will determine whether record companies hit or miss annual performance targets and which will decide whether store groups have a rock-and-rolling Christmas.

More than 40 per cent of annual record sales are made between the end of November and February, and the penultimate Monday in November is when music companies roll out their big guns. Tomorrow sees the release of new – or repackaged – albums from multi-million selling artists such as Oasis, U2, The Beatles, Westlife and All Saints. The array of releases should have the industry jigging in the aisles with excitement.

However, this year more that ever, the record retailers are feeling like the drunk uncle at the wedding; well-intentioned but slightly out of touch. A paradigm shift has occurred in the sector that has blindsided even the most progressive company. While record publishers have begun to find ways of tackling their problems of piracy, declining sales and falling prices, the retailers, such as HMV and Virgin Megastores, are still struggling to compete against digital downloads, online CD sellers and the encroachment of supermarkets on their patch.

Every week, another morbid pronouncement is made. Last month Alain Levy, the chairman of EMI Music, the record label behind Coldplay and Robbie Williams, declared that the CD in its current format is dead. In order to see off the digital threat, from next year EMI will only release CDs with bonus "value- added" content. Worse, Ged Doherty, the new chairman and CEO of Sony BMG, Dido's label, said earlier this month that by 2010 the value of the CD market in the UK could be halved. The decline has already started: the number of CDs sold fell to 158m last year from 162m in 2004.

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The industry is rushing to consolidate to see off this threat. The Sunday Telegraph has learnt that a number of medium-sized music chains have approached Virgin Megastores with cap-in-hand requests to be bought out. These are purely defensive moves. HMV's recent like-for-like sales were down by 5.4 per cent. Even publishers are still struggling to make as much money in the new world as the old. Last week EMI said that first half pre-tax profits fell from £47m to £3.2m.

The reason for the sector's malaise is easy to pinpoint: the way that people consume music has changed. The rise of digital sales, from services such as Apple's iTunes, has taken everyone by surprise. More than 50m tracks will be downloaded this year, double last year's amount. EMI expects digital sales to account for a quarter of its revenue by 2010, up from 9 per cent currently.

High street music retailers cannot even rely on traditional CD sales to prop them up. Supermarkets such as Tesco and Asda accounted for 26 per cent of all CD sales last year from a standing start in 2000, and more than 60 per cent of CDs are now sold at under £10. With sales and margins under attack, it would seem that the days of the traditional record shop are numbered.

However, scratch the surface and there are compelling signs that the traditional music retail sector is well-positioned for the changes ahead. Last week Morgan Stanley, the bank, initiated coverage on HMV with a major piece of research. The bank concluded that HMV's business model is being fixed and that industry-wide structural concerns have been overplayed. "HMV is not a dog," the bank said.

Retailers are adapting their business models to address the new way of doing things. HMV, for example, relaunched its online service earlier this year and cut prices of back-catalogue titles. But there are greater external trends that are working in retailers' favour.

There has been a phenomenal increase in the popularity of indie rock since 2001, and the live music scene is in its best shape for 20 years. The number of UK concerts and festivals is expected to grow by 20 per cent this year, as young fans rediscover live gigs.

This move is being fed by the growth of community websites such as MySpace, which allow bands to put music online and interact with fans (or "friends") like never before. Two of the UK's biggest success stories of this year – Arctic Monkeys and Lily Allen (combined record sales 2m) – grew their fan bases in this way. The site has allowed a mushrooming of underground bands, and is sending more people through retailers' doors.

Gennaro Castaldo of HMV talks of "the iceberg scenario". By this he means that the retail industry only sees the tip of how people interact with music and bands. "There is a massive chunk under water of how fans are connecting. Although sales are mainly done in stores, we as an industry have to engage with that bit under the surface. As an industry we have been culpable of making music a commodity. We are now looking to engage in a different way," he says.

This engagement is partly about selling music in new ways. Recent research has shown that 60 per cent of all new CDs are played first on a computer rather than a stereo. For this reason Island Records recently sold the new single by Keane, the fey indie rockers, on a limited edition memory stick through HMV stores. These are already collectors' items on eBay. This mix-and-match culture of selling both digital and physical product in stores will grow. "The idea that you have to be in a store to buy physical and at home to buy digital is wrong," says one retail executive.

There is also a vinyl revival that is benefiting traditional retailers. In 1989, 79m 7-inch singles were sold in the UK. This collapsed to 100,000 in 2002 but last year 1m singles were sold, and this will double this year. People like the physicality of a single – its artwork, its sleeve notes, its B-side. When HMV hosts in-store signings, fans buy vinyl even though they already own digital versions of the music. "Few people have record players but people will buy vinyl to own it as a piece of art," says Castaldo. The fact that the vanguard of the digital age is also buying round bits of black plastic speaks volumes about the current music revival.

There is also growing evidence of a backlash against supermarkets by the record labels. Last month Tesco, the UK's biggest supermarket, barred key Warner album titles from its shelves. In a bizarre spat over the balance of power between supplier and retailer, Tesco refused to stock new albums by My Chemical Romance, the rock outfit, and P Diddy, the rapper. The fall-out was over Warner's unhappiness with Tesco's price-cutting activity, its "commoditisation" of music. Further disputes are inevitable.

The result of this commercial tension is that record labels are showing increasing goodwill towards specialist retailers, such as HMV or Virgin.

"The supermarkets do not care about the long-term viability of the music sector or marketing new talent. They just sell music as part of their value proposition," says one record music executive.

Morgan Stanley believes that high street music chains can build their market shares along with supermarkets and online retailers. For example, HMV's share is predicted to grow to 23.7 per cent by 2010, up from 20.8 per cent at present. Its online share will almost double to 2.6 per cent over the same period. This growth will come at the expense of general merchandisers – such as Woolworths and WH Smith – and independent stores, whose market share will halve by 2010.

Tomorrow's raft of releases will provide a short-term boost for the sector. But retailers and record companies need to continue to dance to a new beat to secure their long-term futures.